If he were that sort of person Raghuram Rajan would have said, “I told you so!” He had more reasons to say it than almost anyone. In 2005, he shocked a room full of top US policymakers and bankers in Jackson Hole. They were celebrating the legacy of Alan Greenspan, who was about to retire as the Federal Reserve chairman. Rajan argued that financial innovation (partly made possible by Greenspan’s scepticism over financial regulation) had made the world economy less safe.
“I felt like an early Christian who had wandered into a convention of half-starved lions,” recalled Rajan, who is professor of finance at the University of Chicago’s business school and formerly chief economist of the imf. One of the few to sound an alarm before 2007, Rajan was “raining on the parade” that sought to prove that Greenspan was the best central banker in history. No one likes a Cassandra; Rajan was roundly criticised for his views by a cast of luminaries. One of them was the distinguished Lawrence Summers, who now heads the National Economic Council at the White House. Summers derided Rajan for his “slightly lead-eyed premise”.
Two years later, just as Rajan predicted, America’s financial system collapsed and brought the global economy on its knees. Since then the Left has blamed capitalism for what went wrong and the Right has criticised the government. The Left faults greedy bankers on Wall Street and lazy regulators for their hubristic faith in the market and for failing to regulate increasingly dangerous financial instruments. The Right censures the distortions created by the government—specifically, the push for universal home ownership by US politicians, as well as the export-led growth strategy of countries like China and Germany.
How can one begin to fault the noble pursuit of affordable housing for the poor by successive American administrations? Nor can one blame China for achieving prosperity by becoming the premier exporting power. It did such a good job of it that it was soon flush with huge surplus funds which it lent back to America. Like a good vendor, it financed consumption by its customer. But when these well-intentioned policies collided, there was an earthquake. The financial sector was thus merely an agent and not a cause of the disaster. It expanded quickly to absorb capital inflows from both sides and provided the expanding need for cheap housing credit.
Rajan explains that when a government subsidises ownership of a house, capital will flow in that direction. A student of economics knows that when price gets distorted by subsidy, capital will be misallocated, and this is what happened in the disastrous housing bubble. The financial sector is also to blame. While responding to policies of the government, it made a huge amount of bad loans. Stock options and a terrible system of short-term rewards to executives aggravated the stress.
The most provocative claim of Rajan’s is that growing inequality in the US because of jobless growth after 1990 was one of the causes of the crisis. It is well known that incomes of the lower and middle classes in the US have stagnated while incomes at the top have soared. One of the reasons is that the education level of the American worker has not kept pace with the needs of a more technologically demanding economy. Since American politicians could not easily raise incomes, they responded to middle-class insecurities over jobs by giving people more to spend. (Better education, the real solution, would take too long for any politician, as we know so well from our democracy). Politicians of both parties in America encouraged cheap credit instead, especially for housing. “Easy credit has been used as a palliative throughout history by governments that are unable to address the deeper anxieties of the middle class directly,” says Rajan.
The wisdom of this book lies in not taking sides and yet holding everyone accountable. It goes beyond the easy binaries of the mind—of positions taken by the Left and the Right—and seeks deeper underlying fault-lines within the whole system. By and large everyone was following his dharma and acting in reasonable good faith. Yet the result was a catastrophe. How does one cope with this irony? I can think of one way—and that is to accept the humbling verdict of the Mahabharata: that dharma is sookshma, ‘subtle’. This suggests that one should not be hasty in judging others, not even Wall Street bankers. Raghuram Rajan, who grew up in India and continues to be on the Prime Minister’s advisory council, is likely to agree.